income tax department India's oxygen supply chain

Disclaimer: Tax evasion is high in our country, and so is red-tapism. This article is an advisory on how genuine taxpayers can avoid the red-tapism and in no manner, intends to promote tax avoidance, since paying taxes genuinely, is the first step, and in the truest spirit, the smartest way, to avoid hassles from the tax department.

Have you ever wondered? Barely 1% of the population pays taxes in India and surprisingly, 100% of the country is still running, growing, developing and even globally competing with the money collected from the 1% population. Is the income disparity so high in India? Well, there are few myths in this understanding.

Firstly, direct taxes are only 50% of the total collections of the Government and the same is also on the decline, as the Government has found success the alternate ways. When you buy something for personal use, you are already paying taxes (i.e. GST) indirectly. By the end of the year, you would have purchased so many things for personal use and on an average 8-10% of the same is the amount of taxes you have already paid to the Government. Secondly, similar to taxes on goods and services, the Government levies taxes on equity and other security transactions (Securities transaction tax) and also properties. Thirdly, the economic services such as dairy, animal husbandry, Food, Agriculture, Petroleum, Railways, Roads and bridges, Communication services, Research, etc are all areas where Government owns assets and earns from the same e.g. toll tax, police fines, telecom spectrums, sale of defence equipment, food warehouses, etc. Thus, all these collections together help the Government to run our economy.

While the collections from the economic services is not a huge portion, it helps the government to cover its expenses towards public welfare. However, the Government still has the country’s defence and military, roads and railways, space research, educational institutions, and various other development works to manage. The collection from the taxes in a way can be said is used for these purposes. However, even when the country’s tax collections are huge, we are still amongst the developing nations trying to build our space amongst the global stalwarts. This is mainly because of the poor strategies of the Governments and misuse of public money. We live in a world where it is hard to believe that any person would take the responsibility of public office without any self-interests or gains. And that’s where the taxpayers lose faith in the Government and the system of Governance, resulting in lower tax collections.

As we need oxygen to live, the Government needs taxes to run the office. Without the taxes, the Government would fail and in today’s world, it would be a catastrophe! Thus, every effort is made to increase the tax collection and the people at the target of every tax department are the tax evaders – people not contributing to the development of the nation. However, it‘s pretty doubtful that a tax department full of employees who have no impetus to work longer than the expected hours would ever give a better result. However, the even bigger problem is identification – how to identify or track the tax evaders? Tax evaders aren’t terrorist, they are mere people who didn’t want to give a percentage of their income to the Government, mostly because of lack of faith, if the same would ever be used properly. Besides, Indians are smart – they know how to hide. And that’s how the story has been so far – the Government has never been able to find the tax evaders, even after doubling the number of pages in the income tax law!

If you were the Government, what would you do to?

The Tax Department’s Plan

Information! The key constraint of the entire tax conundrum is information – Government needs the information because once they have the information they have the force to work on it and extract the tax money from the evaders. Until the last few years, the tax department used to evaluate your returns, find if there are any problems and resolve or assess the same. However, this did not yield many results as only the people filing returns were being assessed while the evaders were out there. Demonetisation was a big failure as people found ways to circumvent the situation. Several attempts at increasing the number of return filers have been unsuccessful, as people continue to disregard the laws. And thus, realising the ineffectiveness of the prior means, the Government’s plan has shifted from being ‘assessors of information’ to ‘collectors of information.’ Why sit and evaluate information when you can collect the information yourself? This is evident from the following:

  1. Government programmes for linking to Aadhar, to create a database of each person’s activities
  2. Government’s increasing focus on digitalisation of the economy
  3. Government departments entering into ‘Memorandum of Understanding’ (MOUs) for information sharing
  4. Introduction of faceless assessment schemes and annual information statements

The central idea of a digital economy is information – when the world is digital, everything can be traced, tracked and caught. Think of this as GPS in your mobile phone. Because you carry a smartphone, your location is digitally available through accessing the GPS. However, if you do not carry a smartphone, your whereabouts would be difficult to trace. Thus, the Government’s primary focus has been to digitalise the economy and it has been successful with the same.

However, digitalisation alone won’t be helpful, if the information collected doesn’t reach the tax department. And thus, the Government has been aggressively entering into ‘Memorandum of Understanding’ (MOUs) with various other entities. Of course, this could have been done years ago, as many other Government departments are already almost digital, but this is Government and not so surprisingly, it takes years for the Government to pass and process changes in the system.

The success of the Goods and Services Tax (GST) portal has been the real eye-opener for the Government. While citizens continue to abuse the GST portal, it is still one of the best data portals that the Government has ever owned. The information collected through GST returns, e-way bills, e-invoicing and reports have enabled Government to create a huge database of business transactions that can be analysed, traced to the origins and even raise the red flags on its own. The Finance Ministry has finally understood that this is the way forward.

From the budget speeches to the amendments in the laws and changes in the procedures, the Government off lately has been pretty vocal about how they want to change the tax system. The Finance Minister and her team are using terminologies such as data analytics, artificial intelligence, machine learning, etc. to be used in the tax department. However, when a cash-rich company like Google hasn’t mastered the technologies yet, it would be ground-breaking if the Government does! We know it’s not true – words ‘AI’ and ‘ML’ are so trendy that even the Government wants to jump in and ‘portray’ that they are technologically advanced. One thing is true – the Government’s plan is ‘Information’. However, even with information, the Government’s tax collection won’t go up, if the tax litigations keep increasing simultaneously. So, the best sider for ‘Information’ is ‘Fear’. When citizens fear that the Government is capable of doing something, the tax contributions would be higher than before. That’s the best we can make out of the whole ‘AI-ML’ talks of the Finance Ministry.

Sources of Tax Department’s Information

To understand how the income tax department traces income and to ensure that you disclose your income appropriately and maintain ‘social distancing’ with tax hassles, you firstly need to understand how the income tax department collects information and its sources.

  1. Income Tax Return The first and foremost source of information about your income is your income tax return. Income Tax Returns are filed on a self-assessment basis meaning ‘this is my income as per my calculations and the tax payable by me’. When you provide information through income tax return, the same is automatically processed without any human intervention and your income tax refund or tax payable, if any, is determined. Since computers are processing the information, it is important that your income tax return is filled up properly because filling up wrong information can result in computer highlighting the mismatches and therefore, result in tax assessments where more officers would be involved and would cause you more troubles, even if you have paid taxes properly. That’s why it is so important to not just hire experts but to hire the best experts to file your tax returns. By paying a little higher fees to get experts to file your tax returns can save you from hassles in the future and much higher fees, for handling assessments.
  2. TDS/TCS Returns / Form 26AS – Information about your income, if liable to a tax deduction or (tax collection) at source i.e. TDS/TCS would automatically reach the tax department since the person deducting taxes reports your PAN and your income in his TDS returns that he files. Now, although it is beyond your hands, such another person must also file the returns appropriately because if he is mistaken, your income might be reported incorrectly and land you in troubles, not the other person. So, if you notice any mistake in your Form 26AS, request the other party involved to rectify the mistakes before you file your tax return. The Government has recently increased the coverage of TDS and TCS returns to ensure more information reaches the tax department. You cannot escape from filing returns or paying taxes if taxes have been deducted from your income. This has been the biggest source of information for the tax department for decades now.
  3. Tax Audit Reports – For businesses and professionals who are liable to audit under income tax, a long list of information concerning your income is provided by the Chartered Accountants in Form 3CD, the tax audit report. This information is submitted in a database file, meaning the information is auto-populated and auto-matched with the information in your tax return and used to process your tax return and for tax assessment. The report must contain ‘accurate’ information as the tax officers are going to assume the same as true above your words and your self-assessed return. Form 3CD contains various clauses which empower the tax officer with information about critical provisions under income tax. Your tax officer is going to scrutinise your tax audit report and open a ‘Scrutiny Assessment’ if he finds any information unusual or missing in your tax return. So, make sure that your tax audit report and your income tax return reconcile and cross-match with each other in every aspect.
  4. Goods and Services Tax Returns – Oh yes, you read it right! As a result of MOUs with the Central Board of Indirect Taxes and Customs, the Income Tax Department now receives the details of your GST returns (specifically GSTR-3B) filed and the same is being automatically reconciled with your income tax returns. Thus, if you have disclosed certain Sales turnover in GSTR-3B returns, make sure the same reconciles with your turnover in Income Tax Return. If the same is exempt, non-taxable or has different treatments under two laws, make sure you prepare (or ask your tax consultant) a reconciliation of your ‘Turnover as per IT Returns’ vs ‘Turnover as per GSTR-3B return’. Any major differences between the two (even if legal) would be highlighted by the data analytics, as technology and even the tax officer won’t understand the reasons for the same until you explain. The probability of getting selected for scrutiny assessments (or limited scrutiny assessments) would be higher if the turnover does not reconcile. Make sure that even if your turnover is exempt from income tax, the same if disclosed under GSTR-3B, is also disclosed under the exempt income schedule of the income tax return. This would enable you to better explain your turnover reconciliation in assessments later.
  5. Statement of Financial Transactions (SFT) – SFT is a report of specified financial transactions that certain entities such as banks, listed companies, mutual funds, document registrar, etc are liable to submit to the income tax department. These transactions are specified under income tax law and the persons liable to submit the report are expected to maintain a record over the year and file the SFT return based on the record at the end of the year before May 31. However, it is important to note here that the tax department doesn’t get the entire details of your bank account through the bank or the mutual funds through the mutual fund companies. Only the information that such institution is required to report and is reporting, reaches the income tax department. All such transactions would be reported to the Income-tax department and would also reflect in Form 26AS, at the end of the year. While these transactions may have occurred for legitimate reasons and sources, the same must be considered while filing an income tax return, as the tax officer would compare the return filed with the above transactions and may issue a notice to understand the details of the above transactions. The list of specified transactions is as follows:
    1. Annual cash payments for bank drafts, pay orders or banker’s cheque exceeding 10 lakh
    2. Annual cash payments for the purchase of pre-paid instruments exceeding 10 lakh
    3. Annual cash deposits in one or more current account exceeding 50 lakh
    4. Annual cash withdrawals from one or more current account exceeding 50 lakh
    5. Annual cash deposits in one or more savings accounts or time deposits exceeding 10 lakh
    6. Annual fixed or recurring deposits (other than renewals) exceeding 10 lakh
    7. Annual credit card payments in cash exceeding 1 lakh
    8. Annual credit card payments in any mode exceeding 10 lakh
    9. Purchase/buyback of bonds, debentures or shares of a company exceeding 10 lakh in a year
    10. Purchase of one or more schemes of a particular Mutual Fund exceeding 10 lakh in a year
    11. Purchase of foreign currency through any mode exceeding 10 lakh in a year
    12. Purchase or sale of immovable property with a value exceeding 30 lakh
    13. Cash purchases in a year from a particular person exceeding 2 lakh
    14. Dividend distributed by a company during the year, no minimum limit on the amount
    15. Capital gains on transfer of listed equity, securities or mutual funds, no minimum limit on the amount
    16. Interest earned from banks, post office or non-banking financial companies, no minimum limit on the amount
  6. Investigation Wing – The investigation wing of the Central Board of Direct Taxes (CBDT) is a high-level department that keeps checking on tax evasion at a higher level. This wing is also responsible for conducting search and seizures when they have reasonable information about a particular taxpayer.
  7. Other Government Agencies – The Central Board of Direct Taxes (CBDT) has recently entered into a Memorandum of Understanding with the following Government authorities and departments for the exchange of information. These agencies provide the income tax department with data available to them. Central Board of Indirect Taxes & Customs (CBIC) has a huge database of customs clearances for exports and imports. The Government is currently working on building a network between these entities to share the relevant data. These agencies are:
    1. Central Bureau of Investigation (CBI)
    2. Directorate of Revenue Intelligence
    3. Enforcement Directorate (ED)
    4. Central Board of Indirect Taxes & Customs (CBIC)
    5. Cabinet Secretariat
    6. Intelligence Bureau (IB)
    7. Directorate General of GST Intelligence
    8. Narcotics Control Bureau (NCB)
    9. Financial Intelligence Unit (FIU) and
    10. National Investigation Agency (NIA).
  8. Whistleblowers – The income tax department has recently opened an option for any citizen to report details of tax evasion or Benami property by either filing a simple complaint secretly without any rewards or by becoming an informer for the income tax department after disclosing the identity and claiming a reward for the same.

The above sources of income tax department’s information are compiled together and available with the income tax department in respect of all taxpayers which enables the tax officers to analyse returns and complete assessments. Thus, a taxpayer must keep a track of all the above reports, returns, transactions and details which are being filed in his respect by various authorities. The taxpayers must ensure that all such transactions in respect of which the income tax department already has information are reported in the income tax return.

Compliance Portal and Cross-confirmations

The income tax department has recently launched its compliance portal and Annual Information Statement (AIS). The compliance portal is an ongoing dashboard that updates with information from the above sources, every quarter. Currently, the portal is in beta version and is the centre of all future developments. This portal also contains an Annual Information Statement (AIS) which contains more detailed information as compared to a Form 26AS. These are new initiatives where the Income Tax Department is still working and would soon be used more widely. The information on the compliance portal seeks confirmation from the taxpayers concerning information reported by other entity. The income of one person is an expense for another person. Thus, if certain transactions are reported by one entity, they can be confirmed by the other entity in respect of whom such transactions have been reported. Such cross confirmations enable the income tax department to ensure the tax liabilities of both the persons are correct and there is no escaping of income. The entire portal is dependent on information from the above sources and it seems Government will over years intensify the portal by extending the scope of TDS/TCS, SFT etc.

Proper Accounting and Documentation

One of the most common mistakes that taxpayers make is they fail to maintain proper accounting, records and documents of their transactions. This is equivalent to digging one’s own grave. Proper accounting aids in reporting the transactions properly in the tax returns and audit reports. Meanwhile, proper documentation is evidence that the transactions are the way they have been reported. Most taxpayers are not in a position to submit documents asked for in a tax assessment and hence end up paying taxes and penalties. To avoid tax hassles or get quicker resolutions of tax assessments, maintaining proper accounting and documentation is imperative. Most taxpayers do not employ appropriate resources and experts to maintain accounts and records and end up paying more fees than what they saved, besides the taxes and penalties, and most importantly the hassles and the time lost is unmeasurable.

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